Get Ready for the Fall

The bigger they are, the harder they (might) fall.

"The bigger they are, the harder they fall." It's the worst nightmare of every investor in today's market -- buying a hot stock just before it takes a nosedive.

Every day, Nasdaq.com publishes a list of stocks whose shares have just hit new 52-week highs. And every day, investors read the list and tremble -- some with greed, others with terror. On our Motley Fool CAPS investing community, these top stocks usually enjoy favorable ratings, since everyone loves a winner. But what should you do when some of CAPS' smartest investors pan one of these hot stocks?

For starters, consider using the "52-week high" list as a starting point for further research. Stocks can rise for many reasons, but a little help from Motley Fool CAPS can make it easier to figure out how worthy those reasons are. Let's see what the more than 89,000 stock gurus (and counting) in CAPS have to say about the list's latest contenders:

Five stars = highest possible CAPS rating; one star = lowest. Companies are selected from the "NASDAQ 52 Week High" list published on Nasdaq.com on the Saturday following close of trading last week. One-year-ago and recent pricing from Yahoo! Finance, as of the same date. CAPS ratings from Motley Fool CAPS.

"Everybody loves a winner"So people say -- but judging from today's list, not every winner is feeling the love this week. Of the five stocks in our list, each newly arrived on the 52-week-high list, only one enjoys above-average ratings from CAPS players: e-learning provider SkillSoft. More pertinent to today's column: One stock, Herbalife, gets roundly panned and could potentially be heading for a fall. Without further ado, let's dive right into ...

The bear case against Herbalife

Perhaps the kindest cut against Herbalife comes from CAPS All-Star Tucson10, who argued last July that multilevel marketers, or MLMs, "have a life span" and that "this one is in the downslope." Our player continues: "MLMs can be a good investment, but you have to be in them in the first 2 years to really make something. ... If they don't keep things fresh and new, it can die a slow death. Unless they come up with something unique that consumers want, I'm thinking HLF has hit its shelf life."

In companies that do business through multilevel marketing, the parent company recruits one level of salespeople, who then sell products and/or recruit another level, who do the same thing, and so on. Amway might come to mind. You could even say Avon (NYSE: AVP) and USANA Health (Nasdaq: USNA) operate similar businesses -- and indeed, Herbalife considers both companies to be competitors. Of course, folks less charitable than Tuscon10 will often call such businesses by another name: For example, piampiano wrote a year ago that Herbalife is "Ponzi marketing at its finest."

Aside from distaste with the business model, though, is there any other reason to dislike Herbalife? CAPS player amteague777, writing last May, thought so: "[I]t's only a matter of time [before the company's] 'herbal' supplements become the next lawsuit. None of the top execs are major direct holders, which concerns me, especially with their hefty salaries. Oh and the [price-to-book] ratio is 7.22."

I admit, my instinct is to jump on the bandwagon and ridicule Herbalife as being more scam than stock. I've been unable to take this company seriously since the first time I saw one of its advertising signs, hung on a Moscow lamppost and bearing the company's name transliterated into Russian so that it read "Gerbil Life."

I'd love to do that, but the numbers give me pause. Yes, at first glance, Gerbil Life, er, Herbalife, looks horribly overvalued at 18.2 times trailing earnings and only 12% projected profits growth. But that's just the GAAP earnings. Look a little deeper at the free cash flow that Herbalife generates, and you'll find the stock sells for a much more reasonable 13.4 times trailing free cash flow. From a straight valuation perspective, that doesn't look as outlandish.

Time to chime inOf course, that still leaves open the questions: Is the company legit? And even if the business is above board, are its products worth buying? Or, as some CAPS investors suggest, are they a lawsuit waiting to happen?

Author

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.
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